Reference to the CFA’s Advocacy Update from October 6, 2022

Bank of Canada Governor Tiff Macklem said he remains firmly on an interest rate hiking path because of worries about elevated domestic price pressures and inflation expectations becoming entrenched.

Macklem, in a speech Thursday, painted a picture of an economy that is still “clearly” in excess demand, with businesses facing an extremely tight labor market, wage gains broadening and underlying inflation pressures showing no signs of easing.

Canada two-year benchmark yields hit the highest level since 2007 on his comments, jumping more than 5 basis points to as high as 3.976 per cent. Traders firmed up their bets on a 50-basis-point rate increase at the next policy decision on Sept. 26. 

The hawkish comments pour cold water on arguments that the Bank of Canada will be able to diverge from the US Federal Reserve. Before the speech, short-term money markets were betting the Bank of Canada would stop at 4 per cent, about 50 basis points lower than where the Fed is seen heading.

Markets are now pricing in 50-50 odds that Canada’s terminal rate will hit 4.25 per cent. Macklem said that while a recent slowdown in the headline annual reading is “welcome news”, inflation will “not fade away by itself.”

“Simply put, there is more to be done,” Macklem said, according to prepared remarks to the Halifax Chamber of Commerce. “The clear implication is that further interest rate increases are warranted.”

In an apparent signal the central bank doesn’t see itself near the end of its tightening cycle, Macklem said: “We will need additional information before we consider moving to a more finely balanced decision-by-decision approach.” The central bank has already increased borrowing costs by 3 percentage points since March. 

More Highlights

Macklem said there’s some evidence global inflationary forces have begun to ease. But price pressures are increasingly becoming domestic and shifting toward services, which means inflation won’t fall without tightening monetary policy, he said.

Officials can’t count on easing global pressure to lower inflation in Canada for three reasons, Macklem said. It will take time for global factors to filter in, the recent depreciation of the Canadian dollar will fuel the cost of US goods, and there’s considerable uncertainty about evolution of supply chains and commodity prices.

The central banker reiterated his commitment to the Bank of Canada’s 2 per cent inflation target, and urged Canadians to make wage and price decisions based on the assumption it will succeed.

Wage growth has risen and continues to broaden, Macklem said, and businesses are passing higher input costs onto consumers.

Higher borrowing costs are beginning to have some effect, particularly in what had been an excessively overheated housing market, he said.

Macklem said the Bank of Canada is now more focused on the trim and median measures of core inflation while it reassesses CPI-common, which has been subject to large revisions.

The longer high inflation persists and the more pervasive it becomes, the greater the risk that it becomes entrenched, he said, again flagging the risk of wage-price spiral.

Survey results of consumer and business expectations due later this month will be important for the bank’s assessment of how expectations have evolved, Macklem said.

Click here for the Governor’s speech